A business making cross-border payments may find that foreign exchange (FX) rates change between invoicing and settlement, meaning the final amount sent or received isn’t the same as the one originally agreed.
A farm selling apples in the UK to a company in the US will likely agree a price in dollars at the time of the order. However, when the payment is made, the amount received could be higher or lower than expected.
This is because exchange rates can change between invoicing and settlement, meaning the final value of a cross-border payment is not always the same as the one originally agreed upon.
This is known as FX risk and is a standard part of making international payments. However, without an approach to managing it, small currency movements can have a significant financial impact.
Where FX risk is found in international payments
FX risk commonly arises in the gap between agreeing on a price and completing a payment.
If a UK-based business agrees to pay a supplier in US dollars, the sterling-to-dollar exchange rate at the time of agreement may not be the same rate available when the payment is made. Any movement in the rate during that period changes the cost of the transaction.
This is an issue when paying overseas suppliers, where a fixed price in a foreign currency can become more expensive if the domestic currency weakens.
Receiving payments in foreign currencies creates the opposite effect. If exchange rates move unfavourably before funds are converted back into the home currency, the value of that revenue can fall.
The level of risk grows when payments take longer to settle, as longer payment terms can increase this further. Invoices set at 30, 60 or 90 days create a longer window for exchange rates to fluctuate, making final amounts harder to predict.
The business impact of FX movements
One of the main outcomes is that margins are squeezed, as costs rise due to currency movements while prices remain fixed. This means profitability can take a hit or be significantly reduced, particularly in industries where margins are already tight.
Pricing can also become more difficult to manage because businesses are required to decide whether to absorb changes in exchange rates or pass them on to customers.
Cash flow also becomes less predictable when the value of incoming or outgoing payments is uncertain, which makes it harder to plan and manage day-to-day finances, especially for businesses handling high volumes of cross-border transactions across several currencies.
Common approaches to managing FX risk
While businesses can’t completely avoid FX risk, there are several ways they can reduce its impact.
One approach is to lock in exchange rates for future payments using forward contracts, which allow businesses to agree on a rate in advance for a payment that will take place at a later date.
Some businesses manage timing more actively by using spot transactions, where payments are made at the current market rate either immediately or when rates reach a preferred level, offering flexibility but without protection against unfavourable movements.
Natural hedging is another approach, where businesses match money coming in and going out in the same currency, for example, by using foreign-currency revenues to pay suppliers, which reduces the need to convert funds and therefore lowers exposure to exchange-rate changes.
Finally, holding funds in multiple currencies can also help, as multi-currency accounts allow businesses to receive, hold and send different currencies without converting them straight away. This provides businesses with greater control over when exchanges occur and reduces unnecessary FX costs.
The limits of FX strategies
Each approach to managing FX risk comes with pros and cons because methods that aim to reduce uncertainty can also affect flexibility in other areas.
Locking in exchange rates provides certainty over future payments, but it also gets rid of the chance to benefit if the market moves in a more favourable direction after the rate has been agreed.
More flexible approaches, such as using spot rates, allow businesses to take advantage of better rates when they appear, but they also leave payments more exposed to unexpected movements in exchange rates.
There are also cost considerations, as FX services can include fees, differences in exchange rates, or charges linked to specific payment products, which means the overall cost of a transaction isn’t always easy to assess.
Operating across more currencies can also make the process more complex, with different payment flows to manage, currency movements to track, and timing across markets to deal with.
How payment providers support FX management
The way businesses manage FX risk is also influenced by the payment providers they use.
A lot of payment platforms integrate FX capabilities into their services, which allows businesses to access real-time exchange rates, convert currencies within the same platform and better manage international payments.
Multi-currency accounts, automated conversion options and rate visibility tools are becoming more common, giving businesses more control over how and when they exchange currencies.
Some providers also offer forward contracts or similar products, enabling businesses to lock in rates without needing to work with separate financial institutions.
Integration with accounting and treasury systems can substantially improve visibility, helping businesses track currency exposure.
